The IEX Exchange And Its Consequences For Investors

The IEX Exchange And Its Consequences For Investors by Larry Tabb, TABB Group CEO

The SEC has approved IEX and the question now is: How will the approval of IEX impact US market structure? TABB Group CEO Larry Tabb has authored a report, “The IEX Exchange: 8 Consequences for Investors,” which answers these questions. Below is Tabb’s accompanying commentary from TabbFORUM.

The IEX Exchange And Its Consequences For Investors

The SEC has approved IEX, warts and all. The question now is: What’s next? How will the approval of IEX impact US market structure?

In my view, investors will rue this day. Spreads will widen, retail investors will be hurt, larger buy-side firms will be disadvantaged, market structure complexity will increase, sophisticated trading firms will profit, and the quality of the US markets will deteriorate.

Over the past 200 years, and especially over the past 15 years of market structure automation, we have seen two major trends: First, markets have become more deterministic as they have become faster and data quality has improved; and second, spreads (displayed and effective) have tightened. This is completely logical – the faster and cleaner the market data, the tighter firms can quote and trade.

[drizzle]

The same will be true in reverse. The slower and more problematic the data, the wider firms will need to price their trades, as speedbumps, by definition, obfuscate data, slow orders down and reduce the market’s determinism.

The IEX approval presents a number of challenges. This is my take.

Currently, there are 12 exchanges (13 with IEX); seven of the current exchanges have less than 5% market share. These seven markets have the most to gain from copying IEX. That said, these won’t be exact cookie-cutter implementations of the IEX speedbump. We will see many variations on a theme.

If the SEC allows multiple speedbumps, we can absolutely expect an increase in execution complexity. Some markets will be first in: first out; others will have delayed order types. And some will have IEX-like DPEG and crumbling quote-type functionality, while still others will just have differing delays. If, like the movie “Something About Mary” says, eight-minute abs are fantastic, seven-minute abs must be better. We will be seeing a lot of “seven-minute abs” markets, and determining how to trade across these markets and order types will be challenging, to say the least.

Retail wholesalers not only offer immediate execution, they guarantee both the price and size of a retail broker’s clients’ orders. This means that even if the top-of-book size is only 100 shares, wholesalers will guarantee that same price for 1,000 shares. Speedbumps make this retail guarantee problematic.